TERRAFORMING TERRA
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Thursday, September 20, 2012

China's Ghost Steel

What this means of course is that a warehouse receipt in China is no
more than an unsecured promise to make good. None of this really
matters too much if the Chinese banks are happy to accept such
assurances.

Just do not try to sell these securities offshore and do not even
think of buying such paper. What is described here is doubtful
collateral with weak legal process and assured political interference
should due process ever be attempted. I think that I will pass.

We already knew that a lot of Chinese industry is unconventionally
financed and that has been sustained through the stacking on of loans
ultimately supported by the central bank. Remember though that the
underlying enterprises are continuing to operate and sustain cash
flow independent of debt service. I suspect that cash flow is
generally positive though grossly insufficient to service the bank
loans.

Did anyone ever think that perfectly good steel would sit still in a
warehouse? Steel is working inventory and only accumulates in
preparation for a large contract and very briefly at the beginning of
a recession. Just in time manufacturing has put an end to inventory
buildup of any kind.

In the meanwhile, unconventional financing has been the norm from the
beginning and it has worked for them. Similar anomalies existed in
Japan and I am sure elswhere. They are difficult to accept and one
is forced to go back to basics.

How China's
Rehypothecated "Ghost" Steel Just Vaporized, And What This
Means For The World Economy

One of the key stories
of 2011 was the revelation, courtesy of MF Global, that no asset
in the financial system is "as is", and instead is merely a
copy of a copy of a copy- rehypothecated up to an infinite number of
times (if domiciled in the UK) for one simple reason: there are not
enough money-good, credible assets in existence, even if there are
more than enough 'secured' liabilities that claim said assets as
collateral. And while the status quo is marching on, the Ponzi is
rising, and new liabilities are created, all is well; however, the
second the system experiences a violent deleveraging and the
liabilities have to be matched to their respective assets as they are
unwound, all hell breaks loose once the reality sets in that each
asset has been diluted exponentially.

Naturally, among such
assets are not only paper representations of securities, mostly stock
and bond certificates held by the DTC's Cede & Co., but
physical assets, such as bars of gold held by paper ETFs such as GLD
and SLV. In fact, the speculation that the physical precious metals
in circulation have been massively diluted has been a major topic of
debate among the precious metal communities, and is the reason for
the success of such physical-based gold and silver investment
vehicles as those of Eric Sprott. Of course, the "other side"
has been quite adamant that this is in no way realistic and every
ounce of precious metals is accounted for. While that remains to be
disproven in the next, and final, central-planner driven market
crash, we now know that it is not only precious metals that are on
the vaporization chopping block: when it comes to China, such simple
assets as simple steel held in inventories, apparently do not
exist.

From Reuters:

Chinese banks and
companies looking to seize steel pledged as collateral by firms that
have defaulted on loans are making an uncomfortable
discovery: the metal was never in the warehouses in the first
place.

This means that in an
economy in which the creation of liabilities, and pledging of assets
took place at a furious pace in the past 5 years, nobody really knows
just what the real state of credit creation truly was. What is 100%
certain is that as a result of this revelation, the GDP number of the
country, which is and always has been a derivative of credit
formation and expansion (and heaven forbid contraction), is massively
overrepresenting what it is in reality, and that the Chinese economy
has been expanding at a far slower pace if defined not only by the
creation of liabilities, but by matched assets. Most importantly, it
means that every single Renminbi in circulation is impaired as a
country-wide liquidation event would see huge losses
by every creditor class. It also would mean, naturally,
zero residual value left for the equity.

And just like that the
Chinese growth "miracle" goes poof... as does its steel
first, and soon all other commodities (coughcoppercough) that served
as the basis of "secured" liability creation.

Reuters continues,
even if the punchline is already known:

China's demand has
faltered with the slowing economy, pushing steel prices to a
three-year low and making it tough for mills and traders to keep up
with payments on the $400 billion of debt they racked up during years
of double-digit growth.

As defaults have risen
in the world's largest steel consumer, lenders have found that
warehouse receipts for metal pledged as collateral do not always lead
them to stacks of stored metal. Chinese authorities are investigating
a number of cases in which steel documented in receipts was either
not there, belonged to another company or had been pledged as
collateral to multiple lenders, industry sources said.

Ghost inventories are
exacerbating the wider ailments of the sector in China, which
produces around 45 percent of the world's steel and has over 200
million metric tons (220.5 million tons) of excess production
capacity. Steel is another drag on a financial system struggling with
bad loans from the property sector and local governments.

"What we have
seen so far is just the tip of the iceberg," said a trader from
a steel firm in Shanghai who declined to be identified as he was not
authorized to speak to the media. "The situation will get worse
as poor demand, slumping prices and tight credit from banks create a
domino effect on the industry."

Ultra-rehypothecation
101:

Police have arrested
an employee from Baoyang Warehouse in Shanghai and are investigating
documentation for steel stocks that the employee issued to a trading
firm, said an official with the surname Ou at Baoyang. Baoyang is
owned by China Railway Materials Shanghai Company Limited.

The trade firm used
the stocks more than once as collateral to obtain loans, said an
executive at Shanghai Minlurin, another trading firm that had steel
stocks in the warehouse. The receipts used were for steel worth
around 380 million yuan ($59.96 million), the executive said.

If the above makes
readers queasy, it should: after all rehypothecation of questionable
assets is precisely what serves as the backbone of that critical
component of the shadow banking system: the repo market, where
anything goes, and where those who want, can create money virtually
out of thin air with impunity as long as nobody checks if the assets
used for liability creation are actually in the system (and with JPM
as the core private sector tri-party repo entity, secondary only to
the Fed, one can see why this question has never actually arisen).

In the meantime, the
entire Chinese economy is unraveling:

Banks, too, are giving
less credit against warehouse receipts.

"Fake warehouse
receipts have become a problem for some banks and because of this,
many banks have boosted monitoring of existing stocks at warehouses
and temporarily stopped accepting steel stocks as collateral for
loans," said a Shanghai-based branch manager from a Chinese bank
who declined to be identified as he was not authorized to speak to
the media.

Steel mills and end
users rely heavily on trading firms to keep steel flowing from
producers to consumers. Steel traders often buy consignments with
full payment, ensuring cash flow to the mills. End users can buy
small volumes from the traders, more convenient for them than the big
volumes the mills sell.

Industry sources
estimated cases that have already come to light account for about 5
billion yuan ($787.50 million) of bad debt in Shanghai, one of
China's biggest steel trading centers.

At another warehouse,
a logistics unit of giant steelmaker Baosteel rented a small office
to a company called Shanghai Yiye Steel Trade Market Management Co
Ltd. Documents were forged stating Yiye was the owner of some of the
steel stored in the warehouse, said Wang Xueying, the spokeswoman for
the unit called Shanghai Baosteel Logistics Co Ltd.

Yiye used the
documents in dealings with two companies, China Railway Harbin
Logistics and Wuhan Iron Yitong, the spokeswoman said.

The two companies came
to the warehouse to collect the stocks only to find that Yiye did not
own the materials, she said. The case is still under investigation,
she added.

Nobody answered
telephone calls to Yiye made by Reuters to request comment for this
story. Both China Railway Harbin Logistics and Wuhan Iron Yitong
declined to comment when contacted.

In conclusion we can
only add that we hope none of this comes as a surprise to our regular
readers: we have been warning for years that i) the inventory of the
world's credible assets is literally evaporating in absence of
technological efficiency and CapEx spending (which is also the reason
for the ECB's endless lowering of collateral requirements) and ii)
illegal rehypothecation of assets, which infinitely dilutes claims on
real assets, can and will lead to total losses even for investors who
thought they had strong collateral backing.

We now know that this
has been happening in China with the most critical component of its
economic growth miracle: steel. We will soon discover that all other
assets: stocks, bonds, commodities (including gold and silver) and
finally cash (think deposits) have been comparably rehypothecated and
criminally commingled. The end result will be the most epic bank run
in world history, which incidentally is precisely what the central
banks are attempting desperately to delay as much as possible by
generating excess inflation to "inflate" away the debt,
leading to rematching of finite assets and
virtually infinite liabilities. Alas, in a world in which
credit-money liabilities are in the quadrillions, and in which the
real assets are in the tens of trillions, only hyperinflation can
seal the deal.

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Apr 2017 - 4.1 Mil Pg Views, March 2013 - Posted my paper introducing CLOUD COSMOLOGY & NEUTRAL NEUTRINO rigorously described, September 2010 I am pleased to report that my essay titled A NEW METRIC WITH APPLICATIONS TO PHYSICS AND SOLVING CERTAIN HIGHER ORDERED DIFFERENTIAL EQUATIONS' has been published in Physics Essays(AIP) and appeared in their June 2010 quarterly. 40 years ago I took an honors degree in applied mathematics from the University of Waterloo. My interest was Relativity and my last year there saw me complete a 900 level course under Hanno Rund on his work in relativity,as well as differential geometry(pure math) and of course analysis. I continued researching new ideas and knowledge since that time and I have prepared a book for publication titled Paradigms Shift&. I maintain my blog as a day book and research tool to retain data and record impressions and interpretations on material read. Do join my blog and receive Four items of interest daily Monday through Saturday.